How to protect personal liability of senior executives in China

companies and professionals interested in operating on their territory.

This effort brings exciting business opportunities but at the same time

establishes new practices and responsibilities.

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In order to protect their companies’ future and integrity, foreign professionals need to understand that the old “anything goes” culture of doing business in China is no longer acceptable. There is a strong political will in the country to leave the old ways behind and come closer to international standards.

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In the past few years, a series of new regulations have been introduced in China, which have foreign professionals in the country worried about their personal liability. A structural change of approach towards liability issues that emphasizes greater personal accountability of executives has caused additional pressure and skepticism.

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In order to operate under the new rules, it is important to understand the regulatory framework for liability of executives in China, determining who may be liable, to what extent these liabilities may be incurred, and above all, how to mitigate such potential liabilities.

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China’s General Principles of Civil Law establishes that “a company shall assume civil liability for the business activities of its legal representatives and other employees“. Civil liabilities arising out of operational activities shall be generally assumed by the company.

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However, the Chinese authorities have toughened regulations and put more pressure on the person in charge, including legal representative and actual decision makers to enforce these rules effectively. Personal liability can be imposed on those who serve corporate roles in the company if such company commits serious wrongdoings or engages in illegal activities.

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The speed in which the economy has been growing in China and new technologies have been developed, presents new challenges for the local government. In addition, the international pressure on China to open up their market and offer a more competitive play field to foreign companies, has forced Chinese authorities to update their legislative structure.

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Cybersecurity, food safety, environmental protection, e-commerce market and foreign investment are some of the areas that have been recently highly regulated, and which have created new sources of personal liability for the executives.

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In China, personal liability can be incurred to those who work in the company when it commits serious wrongdoings or illegal activities. Personal liability is also stipulated in more sector-specific laws which clearly state that liabilities, such as fines, administrative detention and criminal penalties, will be incurred to person in charge or responsible for relevant matters in the company.

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Personal liabilities can be divided into civil, administrative and criminal, with different legal consequences for each one of them.

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Under China's Company Law, a director or member of "senior management" (general manager, deputy general manager, head of finance or other individual stipulated in a company's articles of association (AoA)) who breaks Chinese law or breaches the company's AoA, must compensate for any resulting damage caused to the company. Given that the legal representative of a company must be either the president of the board of directors or general manager, or the executive director of a smaller company opting not to set up a board, the above would also apply to a legal representative's misconduct.

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In terms of administrative liability, Article 49 of the General Principles of Civil Law establishes that when the company commits serious wrongdoings, the legal representative may personally be subject to fines, administrative sanctions or criminal sanctions. For example, the “person in charge” may bear personal liability in the form of fines up to 100% of the previous year’s income or be dismissed or removed from his/her position for workplace accidents that occur under his/her supervision.

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If the company is found to have breached the Criminal Law, the “person in charge” or “person directly responsible” may also be subject to criminal sentences, as the “Double-Penalty” principle is applied to most corporate crimes.

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In case a crime is committed by a company, both the person in charge or responsible (who could be the legal representative, managers or other personnel) and the company itself will be subject to penalties, while in other cases, only relevant person in charge or responsible will be subject to criminal punishment. Depending on the specific situation, the personnel in charge may be sentenced with detention, imprisonment or even the death penalty.

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Other sentences such as detentions, summons, and restrictions may be imposed on persons involved in the investigation process, even if no liability is determined.

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It is rare though for a legal representative or director to be subject to criminal liabilities if the company is operating within its ordinary course of business. Criminal liabilities are generally associated with intentional conduct or gross negligence which results in serious consequences. Mere negligent or unintentional misconduct typically would not constitute a crime, except for specific offences involving human casualties or substantial economic loss, particularly related to workplace safety.

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The General Principle of Civil Law states that when the company commits serious wrongdoings, the legal representative may personally be subject to penalties. The Company Law establishes that “where any circumstance, in violation of the provisions of this Law, constitutes a crime, the criminal liability of the legal representative shall be investigated”.

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The regulations target the person who is the actual decision maker or the person who could stop the wrongdoings. The “person in charge” or “person directly responsible” is referred to as the person who may bear potential liabilities in many sector-specific laws in China, including without limitation the Criminal Law, Anti-trust law, food safety and Environmental Protection Law.

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In practice, any personnel at any level may be recognized by the authorities as the person in charge of the regulated matters in the company as long as such person has the decision-making power influencing such regulated matter or has been empowered to address such regulated matter.

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The shareholder who does not directly control the operations of the company by serving any corporate positions may also be recognized as the person in charge if he or she retains an effective control over the company through contractual arrangements, such as an investment agreement.

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In addition to assuming liability for his/her own misconduct or negligence, the legal representative may be held vicariously liable for illegal acts committed on behalf of the company by directors or employees.

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A company's legal representative may be subject to fines or administrative sanctions if the company carries out illegal business activities beyond the scope of business approved by and registered with the relevant government authorities; conceals facts from the relevant government authorities or engages in fraud; or removes funds or conceals assets for the purpose of evading debts.

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Similarly, if it disposes of the company's assets without approval after the company is dissolved, has been rescinded or has declared bankruptcy; fails to apply immediately for the relevant registration and make the requisite public announcement regarding a change in the company's corporate information or the termination of its business, which as a result causes an interested party to sustain substantial losses; or engages in other activities prohibited by law, which causes damage to the interests of the state or the public.

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In this regard China's highest court, the Supreme People's Court, pronounced that a fine of up to RMB 2,000 or USD$ 300 as well as detention for up to 15 days, can be imposed on the legal representatives.

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Chinese law does not require a legal representative to have actual knowledge of, or be personally involved in, any of the violations stipulated above. Consequently, a strict liability standard could theoretically be imposed on a legal representative for the acts or omissions of his/her company for any of the situations highlighted above.

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In most cases where the legal representative or director of a company is not allowed to leave China, it is due to the fact that there is an ongoing lawsuit implicating the legal representative, director or his/her company; the company for which the legal representative or director works owes outstanding employee wages and salaries or has entered into bankruptcy proceedings; or there is a failure to execute a court judgment against the foreigner or his/her Chinese companies.

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A company's legal representative must represent the company in commencing or defending civil actions. Therefore, if the company is suing or being sued in China, the company legal representative's presence may, in theory, be seen as necessary to the civil action which may affect his/her travel in and out of China.

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There are a few steps that companies can take to minimize risks, such as the review and update of its organizational structure. In order to protect the top management and ensure the continuity of the business, it is necessary to implement a healthy reporting system.

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Individuals should review their actual powers and responsibilities as defined by the power of attorneys, board resolutions, internal documentation and employment contracts. A contingency plan to ensure continuity of operations is important as well in case the management comes under investigation.

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Companies should establish and enforce a compliance policy, and at the same time encourage a culture of compliance within its structure to make sure their future and integrity are protected.

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Should you have questions about the corporate structure within a company in China or the personal liability and responsibilities for each role,, complete the below inquiry form with your questions and comments.

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DISCLAIMER: All information in this ebook is verified to the best of our ability and is assumed to be correct at time of release; however, Woodburn Accountants & Advisors does not accept responsibility for any losses arising from reliance on the information provided within. The information provided is for general guidance and does not replace specialized advice.